If you already have a 401(k), IRA or other retirement account, congratulations! You’ve taken a huge step to securing tomorrow for “future you.” And, maybe you already know how important your 401(k) account is — but just in case you don’t, they’ve taken up residence as the key method Americans have for funding our futures (in addition to Social Security, of course). In 1980, according to the Employee Benefits Research Institute, 46% of private-sector employees had traditional pensions. Today, fewer than 25% do, according to the Bureau of Labor Statistics. That change shifted the responsibility for paying for your post-work life off the shoulders of employers and onto your own. It was now up to you to sock money into retirement accounts like 401(k)s and IRAs, as well as 403(b)s, 457s, and a menu of other plans for the self-employed.
But what do you do with the money once you’ve contributed it to your plan, or put it into your account? If you want it to grow, you’ll need to put it to work — or invest it — and there are two basic ways to do that.
The Passive Approach
When you first enroll in a company’s retirement plan, you are typically asked to select from a menu of investments (generally mutual funds and index funds). Target-date funds are a type of mutual fund (actually, they’re funds of mutual funds) managed with your retirement date in mind. You choose a fund with a date in the title that lines up with the approximate date you expect to retire and the fund takes less and less risk as it closes in on that date. This way if the market takes a tumble when you’re close to retirement, you aren’t likely to lose as much money. According to PlanSponsor.com, target-date funds were available in almost 90% of 401(k) plans in 2019, and 60% of all plan participants held them.
Importantly, you should know that if you enroll in a plan and start contributing money but don’t select any investments, you’re also likely to end up in a target-date fund that is age appropriate for you. That’s because many plans now have defaults in place to prevent you from leaving your money on the sidelines.
So, is a target-date fund the right approach for you? If you know that you’re not likely to monitor your account or rebalance it at least once a year, yes. If you’re stressed out by the idea of having to select individual funds, yes. If you want to take a more active role in choosing funds for your account — or want to keep costs to the absolute minimum — no. Target-date funds are actively managed, which makes them more expensive than index funds. And one big caveat. Target-date funds are meant to be a one-and-done approach: Putting some of your money into a target-date fund and actively selecting options for the rest is just going to mess up the path the target-date manager has set for you to retirement. Don’t do it.
Note: In the world of IRAs, you may be offered a target-date fund, but if you go with a robo-advisor — whether it’s a standalone or part of a bigger brokerage firm — you’ll also have the opportunity to fill out a questionnaire that will produce an allocation based on your answers. It works very much like a target-date fund. Consider this a one-and-done as well.
What Does It Mean to be an Active Investor?
If you want to play a more active role in choosing the investments for your retirement account, that’s great. The bottom line is that ultimately nobody cares more about your finances (or your investments) than you do. But you should understand that you’re making a commitment. Without your eyes on the prize, you’ll never know when you may veer off course.
Fortunately, being an active investor doesn’t mean checking your portfolio weekly, or changing investments based on the news of the day. Rather, it means understanding where you are now, where you are headed in your financial journey and how your investments need to change as you age and tweak your goals.
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Here’s How to Do It
And no, playing an active role doesn’t necessarily require an advanced degree in finance. In many cases, it comes down to understanding a few key investment terms — in particular asset allocation and rebalancing — which could have a direct impact on your future.
Take asset allocation for starters. This is the balance, or mix, between stocks, bonds and cash in your portfolio. When done right, it balances your risk tolerance with the potential rewards while taking into consideration how long you might need to invest and the balance between growth and income-generating investments.
Rebalancing is a process that realigns your portfolio weightings to maintain your desired asset allocation. When the financial markets change and your asset allocation drifts, your portfolio rides right along with it, altering the amount of risk in your portfolio. Rebalancing your portfolio can be done by hand — or in some cases, your plan or brokerage firm may offer you tools to automate it.
Then there are the things that can’t be automated: Your goals and priorities may also change over time, requiring you to reconsider your timelines, risk tolerance and potentially the construct of your portfolio to obtain new objectives. As stated previously, changing your portfolio isn’t something you need to do often — an annual or semi-annual check-in could be enough.
How to Navigate Portfolio Pitfalls
Finally, it’s important to point out that being an active participant does not mean you should try to time the market (there are reams of research proving that doesn’t work) or react emotionally when stocks are rising or falling. Moving in and out of the market is not conducive to achieving long-term financial success. Worse, it could set you up for losses.
Bottom line: When it comes to successfully navigating the worlds of retirement accounts, the most important thing to do is save as much as you can year-in-and-year-out. Grab every available matching dollar. Put that money to work in a passive or active approach that you’re comfortable with. Stay the course. And get help from a financial advisor with your plan (they all have them) if you need it. Then breathe easy knowing your financial future will be just fine.
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